Dhruv Goyal
Indian markets have maintained a steady upward trajectory, showing remarkable resilience over the past decade. Despite facing challenges such as the COVID-19 pandemic and significant foreign investor outflows, the Sensex and NIFTY 50 have consistently posted positive returns since 2015. Dhruv Goyal, Founder of Four Lion Capital, attributes this strength to strong earnings growth and a flood of domestic capital. However, Goyal warns that rising valuations and potential risks such as slower earnings growth and political instability may dampen future market performance.
"The last time Indian indices saw negative returns in a full calendar year was 2015," Goyal pointed out. Even in 2020-2021, when India's economy shrank by -7.3% due to the pandemic, markets remained resilient. "It was quite surprising that the stock market continued to deliver positive returns during one of the worst economic periods in recent history," he said. In 2022, the market continued its rise, despite foreign portfolio investors (FPIs) pulling out approximately $18 billion as a reaction to aggressive rate hikes by the U.S. Federal Reserve.
Dhruv Goyal emphasized that Indian equities have been buoyed by strong domestic capital and earnings growth. "Domestic capital inflows have been crucial in offsetting the volatility caused by foreign investor outflows," he said. According to him, these inflows have become a significant driving force behind the market's performance.
However, Goyal expressed concerns about valuations, particularly in the small and mid-cap space. As of early September, the NIFTY 50 forward price-to-earnings (P/E) ratio stood at approximately 21.0x, about 3.0 turns higher than its 10-year average. "For large caps, these valuations seem justifiable, thanks to political stability, a strong CapEx cycle, and corporate deleveraging," Goyal noted.
But, he warned, "The small and mid-cap segment is where the valuation issue becomes more pronounced." He pointed out that the NIFTY MidSmallCap 400 Index is now trading at a P/E ratio of 38.6 xs, compared to just 25.4x a year ago. "This suggests that prices are being driven by multiple expansion rather than earnings growth, which is a concern," Goyal said.
Despite these elevated valuations, Goyal believes the market could continue on its upward path, as long as domestic capital flows remain strong. "In August, assets under management (AUM) for equity schemes crossed Rs. 30 lakh crore, or approximately $357 billion a massive increase from Rs. 2 lakh crore in 2014," he said. "That level of domestic investment is helping to provide a solid foundation for the market."
Goyal also highlighted how the ownership structure of Indian equities has shifted in recent years. "We've seen retail and domestic institutional investors (DIIs) increase their share of equity ownership, while FPIs have been steadily reducing their positions," he noted. FPI ownership in the NIFTY 500 recently hit a 12-year low at 18.8%.
A more detailed look at free float data further emphasizes this shift. "FPI free float ownership has fallen from a peak of 48% to 39%, while domestic investors now control 53% of the market," Goyal said. Of this, DIIs hold 35%, with retail investors owning the remaining 18%. "FPIs tend to be more volatile because of their sensitivity to currency risks and global economic changes, whereas DIIs remain more stable," Goyal explained. "As a result, we've seen market volatility drop significantly, creating what I believe is the ideal mix-higher returns with lower volatility."
Looking ahead, Dhruv remains optimistic but stresses that investors should stay cautious. "There are potential risks ahead, including high valuations, particularly in small and mid-caps, as well as the possibility of slower earnings growth or political instability," he warned.
Nonetheless, Dhruv Piyush Goyal believes that as long as domestic capital continues to flow into the markets, Indian equities are likely to maintain their upward momentum. "It's been an incredible run, but investors should be aware of the potential diversions along the way," he concluded.
